Municipal Bonds Are Offering the Yields You’re Looking For. Here’s Where to Look.

Text size

A historic rout in the bond market this year has resulted in the highest yields on municipal bonds in 15 years—and what looks like an excellent buying opportunity.

At midweek, the muni market, as measured by the Bloomberg Municipal Bond Index, was down 13%, its worst showing in at least 40 years, as the yield has jumped to 4.2% from 1.1%. Long-term bond mutual funds have done even worse, off about 15%.

Falling prices, however, mean higher yields, and munis’ are now in the 3% to 5% range, up from 1% to 2% at the start of the year. That’s similar—or even higher—than yields on U.S. Treasuries, particularly for long-term issues maturing in about 30 years.

The benefits after taxes are even greater. A 5% muni offers a tax-equivalent yield of almost 8% for individuals in the top 37% federal tax bracket—5% divided by 0.63—roughly equal to the rate on junk bonds. The tax edge can be greater for affluent residents of high-tax states like California and New York, because in-state bonds are exempt from state and local taxes.

High yields often signal credit risk, but that’s not the case now. The selloff in munis was exacerbated by historically low yields at the start of the year, before the Federal Reserve began raising interest rates. A 5% muni still yields less than the trailing 12-month 8.2% inflation rate, but the markets are discounting sub-3% inflation over the next five and 10 years.

And, historically, municipals have bounced back in a big way in years following large losses. “With bonds, it’s where you start that counts,” says Bryn Torkelson, president of Matisse Capital, which runs the

Matisse Discounted Bond Closed-End
fund (ticker: MDFIX). It owns taxable and tax-free closed-end funds.

Even better, the high yields aren’t a sign of financial stress. State and local governments are flush with tax revenue, while credit-rating upgrades have exceeded downgrades by a 3 to 1 margin this year. A recession could dampen the outlook, but, historically, less than 1% of munis have defaulted each year. A big exception: those linked to the Puerto Rico bankruptcy.

“The combination of higher yields and improving credit quality has made muni bonds very attractive,” says Dave Hammer, head of Pimco’s muni bond investing group, who says municipal finances are as good as he has seen in his 19-year career.

Investment	Recent Price	YTD Return	Yield	Assets (bil)
Mutual Fund / Ticker
Vanguard Intermediate-Term Tax-Exempt / VWITX	$12.85	-10.9%	3.9%	$69.5
Pimco Municipal Bond / PMLAX	8.74	-15.0	3.3	1.7
Parametric TABS 5-15 Year Laddered Municipal Bond / EILTX	11.28	-12.4	2.9	0.6
Pimco High Yield Municipal Bond / PYMAX	7.86	-17.4	4.7	2.2
ETF / Ticker
IShares National Muni Bond / MUB	$101.71	-11.2%	3.7%	$28.5
Closed-End Fund / Ticker				Discount to NAV
BlackRock Municipal 2030 Target Term Trust / BTT	$20.30	-19.6%	3.7%	-8.3%
Nuveen AMT-Free Quality Municipal Income / NEA	10.32	-30.9	5.2	-9.8
Nuveen Municipal Credit Income / NZF	10.74	-34.3	5.6	-12.1
Individual Bond / Cusip				S&P Credit Rating
Triborough Bridge & Tunnel 4% due 2046 / 89602HAA5	83.99	-27.3%	5.2%	AA+
Puerto Rico Cofina 5% due 2058 / 74529JPX7	86.66	-21.4	5.9	Not Rated
Chicago O’Hare Airport 5.25% due 2056 / 167593Y63	96.20	-3.8*	5.5	A+

*Since bond issuance in August

Sources: Bloomberg; company reports

The high inflation readings and the Fed’s moves to boost short rates have rattled individual investors, who own 67% of the $4 trillion in munis outstanding. This year, outflows from muni funds have hit almost $100 billion. “The demand base has eroded,” says Peter Hayes, head of

BlackRock
’s
muni group. He thinks the bonds could rally when investors sense that “the Fed is near the end of the tightening cycle.”

Individuals seeking muni exposure can buy open-end mutual funds like the $70 billion

Vanguard Intermediate-Term Tax-Exempt
(VWITX), which carries a low fee and currently yields 3.9%. Another intermediate option: the

Parametric TABS 5-to-15 Year Laddered Municipal Bond
(EILTX), which holds an equal weighting of bonds with five- to 15-year maturities.

Muni ETFs are small relative to mutual funds but gaining share. The largest is $29 billion

iShares National Muni Bond
(MUB), yielding 3.7%. It buys investment-grade munis.

The real opportunity might be in closed-end funds. They carry more risk because most use leverage, with about 50 cents of borrowings for every dollar of equity. This amplifies returns when prices rise, but hurts in a down market. Borrowing costs have risen this year to 3% from 1%, reducing the benefits of leverage, and leading to some dividend cuts. The $3.4 billion

Nuveen AMT-Free Quality Municipal Income
CEF (NEA) recently slashed its payout 15%.

The risks are reflected in prices 9% below the funds’ net asset values, versus near parity at the start of the year. The closed-ends offer a “double discount,” says Torkelson, referring to the depressed prices and discounts to NAV.

The

BlackRock Municipal 2030 Target Term Trust
CEF (BTT) trades around $20, 8% below NAV. It yields 3.7% and aims to return $25 a share to holders at maturity in eight years.

Investors can buy individual bonds, too. BlackRock’s Hayes likes intermediate munis, whose yields are close to 4%. Higher, 4.5% to 5% yields are available on high-grade long-term munis. They include the Triborough Bridge and Tunnel Authority (New York) 4% issue due in 2046 yielding 5.2% and the Chicago O’Hare Airport 5.25% issue due in 2056 with a 5.5% yield. In contrast, the 30-year Treasury yields 4.1%.

Pimco’s Hammer sees opportunity in high-yield munis with junk ratings or none at all. He’s partial to the restructured Puerto Rico Cofina bonds, which is an acronym for the Spanish name of the agency that collects sales taxes on the island. The Cofina 5% due in 2058 trades around 86 cents on the dollar and yields about 6%. Sales taxes would have to decline 50% for the bonds to be impaired. They fell about 13% during the 2008-09 financial crisis and 3% after the devastating Hurricane Maria hit the island in 2017.

Hammer also likes some “tobacco bonds,” issued by states and backed by cigarette companies’ payments under the Master Settlement Agreement established 24 years ago. The largest issue, the $3 billion Ohio Buckeye 5% due in 2055 yields 6.1%.

Funds investing in the area include the

Pimco High Yield Municipal
fund (PYMAX), yielding over 4%, and the

Nuveen Municipal Credit Income
CEF (NZF), yielding 5.6%.

Write to Andrew Bary at andrew.bary@barrons.com